TheBull PREMIUM

Cheap Stocks With Earnings Tailwind From Low Aussie Dollar

The race is on to find stocks that will benefit from a lower Australian dollar as broking firms busily downgrade currency forecasts and update valuations for companies with offshore currency exposure.

Macquarie Equities Research this week trimmed its medium-term forecasts for the Australian dollar by an average 11 per cent across 2013 to 2017. The 2013 forecast was lowered from US$1.02 in 2013 and 2014 to US90 cents and US89 cents respectively, and from US$1.01 to US87 cents in 2015.

AMP Capital chief economist Dr Shane Oliver believes the Australian dollar needs to fall even further. In a research note this week, he wrote: “Our rough estimate is that to offset the relatively high prices and costs, the Australian dollar needs to fall to around US75-80 cents.”

Merrill Lynch predicts the Australian dollar will hit US88 cents by late 2014.

A falling Australian dollar is already a strong contender for this year’s investment market “X-factor”. Although it has been overvalued for several years against the US dollar, it has stubbornly refused to fall below parity due to this nation’s perceived status as an investment safe haven.

The trend is rapidly changing: after flirting with US$1.06 at the start of 2013, the Australian dollar hit US92.66 cents and is in a clear downtrend.

Two game-changers for the Australian dollar have recently emerged. First, a stronger expectation that interest rates need to be cut to boost the sluggish local economy. Second, that the US Federal Reserve will taper its quantitative easing program and end it in mid-2014. The prospect that the Fed will stop printing money as the US economy improves has seen most currencies depreciate against the Greenback.

The Bull.com.au has followed this trend closely in 2013. Several instalments of this column have highlighted the likelihood of a falling Australian dollar this year and identified ways to capitalise on this powerful trend. Chief among them was using ASX-listed exchange-traded products that offer pure currency exposure, to benefit as the Australian dollar retreats.

Another option is investing in international equity funds, including unit trusts or listed investment companies, that are unhedged for currency movements. AMP’s Dr Oliver wrote: As the Australian dollar continues to trend down, unhedged international equities will outperform.”

The other option is choosing companies that benefit from a lower Australian dollar, either through the currency translation effect of repatriating profits earned offshore back home, or a more competitive export position. Miners that earn US-dollar revenues also benefit.

I’m always wary of trying to pick stocks based on currency “winners and losers”. Although such stories make for interesting headlines, the effect of currency moves on corporate profits is not always clear-cut. Moreover, the sharemarket often prices in a lower currency long before the event.

Investors who bought gold stocks in anticipation of a rising gold price mostly learned a painful lesson in the dangers of company and market risks outweighing a rallying gold price between 2008 and mid-2011. The ASX-listed gold sector has chronically underperformed the gold price in recent years; investors who sought pure exposure to gold should have used an exchange-traded commodity.

The other problem is a weakening Australian dollar signals other problems. Our currency’s decline is partly because of falling commodity prices (our dollar has so far lagged falls in metals) and expectations of lower interest rates, to help an increasingly sluggish economy, which is bad news for Australian companies and this sharemarket generally.

The challenge is finding stocks that already stack up well on valuation grounds and will get an earnings tailwind from the falling Australian dollar. Put another way, look for stocks that are good investments even if the Australian dollar consolidates around current levels this year.

Such analysis typically focuses on Australian companies with a large chunk of earnings from the US: for example, Computershare, James Hardies Industries, Brambles, and Westfield Group.

Large Australian mining companies look more interesting at this point in the cycle. The resource sector has been smashed in the past year: the S&P/ASX Metals and Mining index has slumped 20 per cent so far this year and sector leaders BHP Billiton and Rio Tinto are well off their 52-week highs.

Both stocks have US-dollar earnings bases and mostly Australian-dollar denominated cost bases, meaning the lower Australian dollar boosts their earnings. BHP’s US-dollar dividends will also look better as the Australian dollar retreats.

Macquarie wrote: “As a result of our revised medium-term currency forecasts, BHP, Rio Tinto and Fortescue Metals Group see average earnings increases of around 13 per cent from 2014-2017 as the Australian dollar falls, while our commodity price forecasts remain unchanged.”

Macquarie prefers BHP over Rio Tinto due to its more diversified asset portfolio, and has a 12-month price target of $39 for BHP from $32.99 currently. Among mid-cap miners, it favours BC Iron, Whitehaven Coal, PanAust and Western Areas. In gold, Regis Resources, Beadall Resources and Papillon Resources are its best picks.

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.